The Stock Market Freefall From A Bankruptcy Perspective

The irrational exuberance (borrowed from Alan Greenspan) with respect to the continued increase in the stock market has led many investors to purchase even more securities on margin. The recent freefall will trigger substantial margin calls, which in turn will require additional selling of securities at a loss, and in many instances it will create a cash crisis for the investor whether large or small. In past economic downturns involving the stock market, this has led to a substantial number of unexpected bankruptcy proceedings.

Most European corporate borrowings our dollar denominated, even if the borrowings are from European banks. Over the last several months, and exponentially worse over the last several days, the dollar has become stronger against the euro and other European currencies. This means that interest has risen by at least a third on these loans, and unless there is a balancing of the dollar as against the European currencies, the principal balance of the loan to be repaid will also increase by 33% or more. This will lead to significant payment defaults by corporate borrowers in Europe, which will put increase pressure on banks, and in turn lead to business failures, receiverships and bankruptcies.

Because of the stronger dollar, European customers of goods manufactured in the United States will be more constrained with purchases, which will create a slowdown in the export of goods from the United States.

Many municipal pension plans are underfunded. In order to maximize returns, investments have been made by the fund managers in equities as opposed to a more conservative investments. With a rapid fall in the value of the equities (stocks, mutual funds or hedge funds), the overfunding will become even more exacerbated. Unless there is a rapid recovery, this could lead to an influx of municipal bankruptcies under Chapter 9 where the already precarious retiree issue will be brought to a head.

Smaller insurance companies regularly invest in equities in order to create a higher return for shareholders. Most states do not regulate the types of investments made by these insurance companies. If the equity market falls too far, this could create a lack of liquidity on the part of the insurance companies, which then will force a possible rehabilitation, insolvency or receivership when a state-by-state basis. Historically, smaller insurance companies have suffered greatly when there has been a crash in the stock market. This, then, requires the state which oversees the insurance company to bail out the policyholders had a substantial cost to taxpayers.

Fresh

An op-ed by Tripp Scott's Douglas Reynolds and Henny Shomar. As published in the DBR.

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